Squeeze out clause – A perspective
By Anup Koushik Karavadi
‘Squeeze Out’ provisions in the Companies Act, 1956 enable the majority shareholder holding above a prescribed threshold limit to “squeeze-out” the minority shareholders and acquire the entire shareholding in a company.
Shareholding – Majority rule & minority rights
Shares in a company comprise a bundle of rights and responsibilities subject to the conditions and terms of its Memorandum and Articles of Association as well as the Act. Mutual agreement among shareholders on the manner in which a company is managed is the fundamental principle of corporate management and ownership. Such mutual agreement is a contract between shareholders and is enshrined in the articles of association and subject to consensus amongst themselves. It is not possible for each shareholder to participate in the decision making process on a day to day basis and hence the principle of majority owned and controlled corporations affords operational convenience in corporate decision making.
The “Rule of Majority” principle finds its roots as early as in the year 1843 as stipulated in Foss v. Harbottle (see end note 1) where, it was held that the courts would not generally interfere with the decisions of the company which it was empowered to take insofar they have been approved of by the majority and made exceptions to breaches of charter documents, fiduciary duties and fraud or oppression and inadequate notice to shareholders.
It is to be seen whether the system of “Rule of Majority” jeopardize the rights of the minority shareholder and squeeze them out of the company?
Majority Rule - Justifications quantified
Utilitarians have always justified majority rule in terms of the convenience in decision making. This theory is supported by the economic approach that higher rights and authority is directly proportional to percentage of ownership, giving the majority greater decision making power (see end note 2). This would translate into a right of this majority beyond a specified threshold to decide whether it needs minority shareholders and if not the power to buy them out regardless. In terms of Squeeze out by third party bidders, Grossman and Hart (see end note 3) characterize minorities as free riders on investment risks thereby justifying the right of such bidders to squeeze out minority shareholders.
The more legal justification often adopted by courts is based on the Foss v. Harbottle rule that the majority proprietors are the beneficiary of a trust of the company and every person who enters the company, by the very terms of its incorporation, agree to be bound by the decision of the majority. The only rider to this principle has been the ‘business purpose’ test which at once can challenge the wisdom of the majority and challenge their decision on grounds of fiduciary duty to cater to the best interest of the company (see end note 4).
Minority Rights - Right to one’s own property
On the other hand, squeeze outs are considered as a depravation of property and when squeeze outs are enforceable under law, they amount to dispossession of property under the law. Under this approach dispossession of property must occur only in cases of public or general interest (see end note 5). However, this argument has been overturned by European courts by equating public interest with ‘efficient management’ of companies thereby justifying ‘legal’ provisions enabling squeeze out (see end note 6).
Another objection to squeeze out rights to the majority is based on grounds of fairness. Minority shareholders cannot be rendered powerless in terms of their shareholding in the company. However, Courts in India do not seem to support a right to be consulted unless statutorily provided for and have upheld majority attempts to cordon off minority rights through indirect squeeze outs (see end note 7).
Current legal position
Section 395 of the Companies Act provides for the process of squeezing out shareholders who dissent to an acquisition of shares otherwise approved by shareholders holding 9/10th in value within four months of the offer. The ‘transferee company’ may give notice to the dissenting shareholders in the next two months expressing its interest in buying their shares and then becomes entitled and obliged to buy such shares upon the expiry of one month from the date of notice.
If the transferee already owns 10% or more of such shares then the scheme needs to be approved by shareholders holding 9/10th in value and being ¾th in number of the shareholders holding such shares. The dissenting shareholder ought to be offered the same price as the other shareholders in such a case. The transferor company is paid the amount towards the shares of such shareholders and it is liable to disburse the same in their favor.
Upon notification, the dissenting shareholder may approach the tribunal to allow its application which would entitle such shareholder to continue to hold its share. The court shall allow such application if it were shown that the process was unfair or the price offered was undervalued, or the scheme was unjust, unconscionable or consent obtained thereto involved fraud (see end note 8). It cannot be a scheme by the majority to expropriate the minority.
The various safe-guards under Section 395 lead to companies using ‘reduction’ provisions under Section 100 to squeeze out minorities by extinguishing their share in return of consideration. These provisions do not have the high voting requirements as in case of Section 395 and a special resolution suffices to approve the scheme therein. Such schemes have been upheld by the court in In re Sterlite Industries (see end note 9) and Sandvik Asia v. Bharat Kumar Padamsi (see end note 10) whereby the courts have allowed companies to squeeze out minorities indirectly under a scheme of reduction. The courts therein held that the Act allowed companies to extinguish share capital and the court would uphold such a scheme in all cases where creditors have consented and the shareholders have received fair compensation. The court ignored the well accepted principle of “Quando aliquid prohibetur ex directo, prohibetur et per obliquum” or in plain English, what cannot be done directly cannot be done indirectly.
In case of listed companies, the Securities and Exchange Board of India has provided for various open offer triggers under the SEBI (Take-over) Code, 2010. Both direct and indirect acquisitions of shares are regulated by the said code. The code provides for voluntary public offer to those acquirers having 25% to 75% holding in the shares. The takeover code is designed to provide shareholders with necessary information and a limited option to exit. However, it does not regulate or protect against squeezing out.
Companies Bill, 2012
The Companies Bill (“Bill”) awaits the approval of the Rajya Sabha. Clause 236 of the Bill provides an option to the acquirers or the persons acting in concert holding 90% or more of the issued equity share capital to notify the company of their intention to squeeze/buy out the remaining equity shares. The point of relevance in relation to the proposed squeeze out clause is that, it obligates the majority to notify the intention to buy out the shareholding and does not give away the right to the majority shareholders to buy out the minority shareholding out right. Further, the Bill does not provide for any time requirement within which an offer has to be made by the majority.
Further, as per the Bill, the tribunal shall send notices to the central Government and the SEBI (in cases of listed companies) when a scheme for reduction of capital is presented before it, thereby allowing objections to be raised by the regulators. Reduction provisions in the Bill provide an additional level of protection to the minority shareholders from being “squeezed out” under other provisions.
Minority rights cannot be seen as a ‘management’ problem and must be given due recognition and importance. The principle of majority rule is to afford greater flexibility to decision making. However it cannot be used to deprive a person or groups of persons of their property. The principle in Foss v. Harbottle is still relevant and the court was right in ruling that every shareholder is bound by the terms of incorporation of the company (and it operated as a set of mutually binding obligations) however in the process of implementing the objectives of the company one cannot override the legitimate expectations of the parties under the contract. Minority rights need to be looked at with greater care and caution and the principle of majority rule should not jeopardize the democratic system of corporate governance and turn itself into ignoring the minority and placing all the authority with the majority to do as it wants.
1. (1843) 67 ER 189
2. Ataollah Rahmani, A comparative Study of Justifications for majority rule in Corporations: The Case of England and Iran, 282 [I.C.C.L.R. 2007, 18(8) 279-294, (2007)]
3. Grossman S. and O. Hart, Takeover Bids, The Free Rider Problem and the theory of Corporation, Bell Journal of Economics 11, 42-64.
4. Supra Carney at 97.
5. Christopher Van and en Lientie, Supra foot note 6 at 13.
6. Id at 14.
7. Sandvik Asia Ltd. In Re  92 SCL 272 (Bom)
8. A Ramaiyya, Guide to the Companies Act 4210 [17th ed. Part II Lexis Nexis Butterworths (2010)]
[The author is a Senior Associate, Corporate Practice, Lakshmikumaran & Sridharan, Hyderabad]